How to Strengthen your Capital Allocation Model Post Pandemic

How to Strengthen your Capital Allocation Model Post Pandemic

COVID-19 left many leaders uncertain about their capital allocation model. In fact, 56% of CFOs worldwide said, “their capital allocation strategy needs to be completely rethought” following the pandemic.

After an unexpected crisis like COVID-19, it’s tempting to approach capital allocation decisions as quick fixes. Your expenditures are based on the short-term fires you need to put out.

But as the world enters the new normal, CFOs can focus on building a long-term strategic capital allocation framework. This approach doesn’t mean forming a spending plan you’re glued to for years. It means building a foundational capital allocation model that serves as your bedrock yet is flexible enough to leave room for adjustments.

Ensure Agility To Make it Through Market Shifts

Many CFOs make corporate capital allocation decisions on a yearly basis. But when you only think about the company’s capital allocation model annually, it can be hard to evaluate if the investments are paying off, or just as difficult to quickly course-correct when needed.

Consider the impact of COVID-19 last year. Many businesses had to completely rethink their annual capital allocation methods to adapt to the sudden market changes.

How can you build an agile capital allocation model to make it through market shifts?

With the help of data. When you can easily assess investment performance and alternative choices, you can course-correct quickly in response to market changes or less-than-expected investment returns.

Finance data is more accessible across your organization when you invest in a robust FP&A platform. This technology can help you keep track of numbers and respond to unplanned changes. Thanks to its integrations, Planful allows finance teams to collaborate with other departments on the platform and view data in real-time to make capital allocation decisions. 

The point here is that numbers on their own have little value to finance teams until they’re transformed into structured information. Planful helps you convert finance data into information, and then into knowledge based on context and trends to help you make better, data-driven capital allocation decisions. 

Take Smart Risks for Greater Returns in the Long Run

Companies can get stuck in a rut when finance leaders make the same investment decisions because they seem safe. With the uncertainty of the pandemic, CFOs can’t determine if now is the time to make drastic changes to investments relative to pandemic levels.

But safe isn’t necessarily good for the business.

Diversifying investments and allocation can benefit the organization and produce more returns. According to a study by McKinsey, companies that have diversified investments will be worth around 40% more than companies that don’t.

CFOs should take risks—as long as they’re calculated.
We recommend three steps to take smarter risks when it comes to your capital allocation approach:

Identify the consequences.

  • Consider how the risk in question could impact your tangible bottom line and your less quantifiable bottom line—customers, partners, and employees—over a specific time horizon. Brainstorm with the team to recognize possible positive or negative impacts and identify blind spots. Determining worst-case scenarios can help you prepare for them.

Analyze different impacts. 

  • Play out a mix of scenarios ranging from conservative to aggressive. Assess confidence in success and tolerance for risk to develop mid-course adjustments and contingencies, and figure out the likelihood of failure. By doing this, you can recognize potential threats and plan for them accordingly.

Develop your capital allocation model.

  • Decide where to allocate capital based on strategic priorities that drive broad debt and equity choices. You can revisit the decision later if you need to free up funds for another investment or area of business.

A comprehensive FP&A platform like Planful offers tools for finance teams to perform scenario analyses and understand potential impacts in minutes, instead of the days or weeks it would take by manually performing the capital allocation process.

“Our forecast system was error-prone and time-intensive. Now, we can create multiple scenarios, and we have immediate visibility,” says Tim Zue, EVP & CFO at Boston Red Sox. “What used to take us days now takes us minutes with the click of a button.”

Include More Voices in Capital Allocation Decisions Through a Fair Governance Process

A good capital allocation model empowers companies to anticipate outcomes that could impact the company and plan accordingly. This foresight is even more relevant in light of COVID-19, which blindsided finance teams.

Businesses are better able to prepare for the unexpected when they include a wide range of people brainstorming possible scenarios and offering input. On the flip side, capital allocation choices are susceptible to biases when few people are involved in the decision making. If one or two people dominate the conversation, allocation will be limited to their experiences and ideas.

Research backs this up. And, according to BCG, capital allocation decisions are prone to cognitive biases such as:

  • “framing decisions too narrowly”
  • “relying too heavily on readily available information”
  • “anchoring,” which is a reluctance to process new information and adapt accordingly
  • “falling into ‘group think’” as it involves decision making that silences individual disagreement

A fair governance process for the company’s capital allocation model can help reduce bias and add more voices to the investment decisions. 

BCG’s Ulrich Pidun and Sebastian Stange recommend the following steps to ensure good governance in capital allocation:

“Address cognitive biases.”

  • Set up a committee to regularly review and offer input on capital allocation proposals. Bundle projects together to be discussed quarterly, semi-annually, or annually. Ensure allocation proposals come with alternatives, and create a culture of cognitive diversity by allowing “constructive disagreement.”

“Establish accountability.”

  • Encourage project leaders and decision-makers to scrutinize their plans—test out alternatives, play various scenarios in advance to identify the likelihood of working out—so the project is a success even if they’re not leading it. You can do this by providing incentives for the proposal rather than the results.

“Institute feedback loops.”

  • Feedback is essential to evaluate if investment performance is as expected and to help you revisit decisions if needed. Once capital allocation decisions are made, ensure there’s a structure that supports feedback from those implementing the decisions, be it project managers or division managers.

By having a variety of voices shape capital allocation, your company is better equipped to choose expenditures that support the company’s growth and resilience—even in the face of black swan events like COVID-19.

Continuously Revisit Your Capital Allocation Model as Needed

There’s no need to make capital allocation decisions solely on an annual basis. As COVID-19 shows, the world can quickly change in ways that upend year-long plans. With today’s financial planning technology, it’s easier than ever to revisit your investment decisions frequently and adapt as needed.

Find out how Planful can help you create better capital allocation models with agile continuous planning.

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